What Is An Index Tracker And Why Should You Care?

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If Index Trackers were a rock band I would be one of those lunatic groupies following them around from gig to gig and flinging my nickers onto the stage!

Fortunately for me and my ever-expanding adoration, Index Trackers are way more sexy than Mick Jagger’s hips (I know I’m giving my age away but Justin Bieber’s crotch grabbing just doesn’t do it for me), you don’t have to lose any underwear to prove your love and they do all the giving by significantly increasing your investment returns and bringing money into your world.

Tweet : As investors, there are only two things which we can control: the fees we pay, and the assets we invest in. Index Trackers give you the best of both.

An index tracker is a low-cost, simple investment fund that mimics the performance of the stock market. To understand how they work, it’s useful to know a little about stock market indexes. An index is a method of tracking how well a stock market, or a particular sector of it, is performing. It enables investors to assess how well they’re doing with their investing, by comparing their own performance against the market. They can see if they’re out-performing (doing better than the index) or under-performing (doing worse).

Each index is made up of many different companies. When you hear on the news that “The Dow Jones is down 100 points” or the “Footsie has risen 50 points today”, the news anchor is referring to the stock market indexes of the New York Stock Exchange and the London Stock Exchange, respectively.

What does a rise of 50 points mean? Say the FTSE 100 index rises by 50 points from 5,000 to 5,050, or 1%. This means that the value of the top 100 companies bought and sold on the London Stock Exchange has gone up by 1%.

There are literally hundreds of different indexes across the world. As well as tracking the markets of whole countries, there are also indexes which track individual industries or sectors, such as retail, industrial or property or large geographical regions such as Europe, Africa or the Far East.

In the US, the main indexes are the Dow Jones Industrial Average (the Dow), the Standard & Poor’s and the Nasdaq (where most technology shares are listed). In the UK, it’s the FTSE which tracks the performance of the largest companies listed on the London Stock Exchange, and in Australia the main index is the ASX: the Australian Stock Exchange. Others indexes you’ll come across include the Nikkei (Japan), the Hang Seng (Hong Kong), the Dax (Germany), the CAC (France), the TSX Toronto Stock Exchange (Canada) and, the JSE (South Africa).

An index tracker is a fund that holds shares in the same proportion as a specific index.

So, a FTSE 100 tracker, for instance, attempts to mimic the performance of the 100 largest companies listed on the London Stock Exchange.

When the companies that make up an index change (because say one company performs badly and drops out of the index or another performs really well and gets into the index), the index tracker fund will adjust its holdings accordingly. An index tracker, therefore, differs from most other funds – collectively referred to as ‘Managed Funds’ – where it’s the fund manager who decides when and which companies are bought and sold.

Simply put: an Index Tracker fund is an investment fund comprising of shares in companies mirroring a specific index. Because the share selection is based on mirroring the index, a computers does the buying and selling not an expensive human being which brings us to one of the reasons Index Trackers are so hip swingingly sexy.

Why are Index Trackers so much juicier (and better for your wealth) than Managed Funds?

The first and main reason why I love Index Trackers and you should too is because in all probability your wealth will grow significantly faster and bigger with them in your asset drawer!

A study by research firm WM Company found that 82% of managed funds failed to beat the market (the index) over the course of twenty years.

Let me repeat that in case you didn’t get the enormity of that fact. Less than 18% of Managed Funds – (those investments 99% of financial advisors put their clients into and charge for the pleasure, and which 99% of your retirement and pension investments are invested in) – give a better return than the market average!

I hope you get how shocking that is but it gets worse… this figure only includes funds that survived for the entire twenty years.

Many poorly-performing funds are shut down or simply merged into other funds. This means that the chances of picking a fund now that will do worse than the market over the next twenty years, is likely to be well in excess of 90%. A 10% chance of your investments performing better than the market is a pretty dismal thought especially when you are paying for that shocking performance AND even if the fund performs as well as the market you still lose.

Why you still lose even if the actively managed fund performs as well as the market.

John Bogle, founder of the US-based fund giant Vanguard, backs this up. Bogle looked at the returns of investing $10,000 over a 25-year period: if you’d invested the money in an actively-managed retail fund 25 years ago, your $10,000 would have grown to $48,200. However, putting the same amount into a broad index-tracking fund with low fees would have grown it to $170,800 – a huge difference of $120,000!

That means 99% of people who believe they are looking after their financial wellbeing by going to a financial advisor and investing in actively managed funds or putting money into their retirement investments which in turn are going into actively managed funds could end up getting 70% LESS than they should.

STOP AND CONSIDER THIS FOR A MOMENT

What difference could that 70% make in your life?

What difference could that 70% make in terms of the choices you have?

What difference will that 70% make in terms of the lifestyle you can live?

What difference will that 70% make in terms of your peace of mind and the financial security you would feel knowing you have all the money you need to support you no matter what life throws your way?

What happened to that 70% you lost?

That gob-smacking 70% difference is made up of high fees charged within the fund to pay for those hefty salaries and bonuses of those fund managers who underperform the market and expensive advertising used to con you into thinking these actively managed funds are good for you, PLUS kick-back commissions paid to financial advisers who put you into these funds.

A typical actively managed fund ongoing management charges are around 1.5% a year with many adding ridiculous additional charges like front end investment charges or exit fees of up to 5% and performance commissions which make the average actively managed fund costs around 2,5%. The average index tracker ongoing management charges less than 0.5% and some charge as little as 0,1% with no upfront charges or other sneaking fees.

Financial Advisor commissions typically range from 0,5% to 3% of the value of your investments and you pay these each and every year on the value of your investments for as long as you are invested in those funds even if you never hear from that advisor again.

These differences may sound small, but they compound each year and give index trackers a huge advantage over the long term.

In addition to a higher expected return, index trackers have one final major advantage over managed funds: they are much simpler to operate. Essentially, you just pick your tracker and leave it to do its job for twenty years or even longer.

What is the difference between Passive Investing and Investing In Index Trackers?

If you’ve read this far I’m hoping you are salivating when you realise what Index Trackers can do for you but perhaps you’ve heard the phrase Passive Investing and you are unsure how that relates to these sexy Index Trackers.

Index tracker funds are called Passive Funds because the selection of company shares which go into the fund are selected passively by mirroring the market unlike Active Funds where a human being actively makes the selection.

In other words – actively choose the smart path of using Passive Investment Funds (i.e. Index Tracker funds) rather than passively ending up in actively managed funds and paying the significant costs just because you didn’t understand the consequence.

JOIN THE WEALTH CONVERSATION

2 Comments

hi Ann, ive been follwoing you for sometime and have invested in index trackers. however i need to know which ones i should be investing in. as a single mother in south africa i want to make the right choices. Investing in the JSE seems like a terrible idea given the rollercoaster we’re on. is it better to invest in the FTSE or NASDAQ Trackers. I haev also suggested them to my sister who desperately needs to invest for her and her kids but i dont want to have her buy into index trackers that dont do as awell as others may.
i need some giudance. where do i get that?

Hey Jeanne, firstly, huge acknowledgement to you for even being here and taking these massive steps to take responsibility for your own financial wellbeing. The way to manage the rollercoaster is to understand it. The JSE isn’t actually scary at all and as you are based in South Africa it is actually a very important part of your investing, but you need a balanced portfolio. Join Nerina and me in this FREE masterclass where we expand on how you do exactly this. http://passiveinvestmentmastery.com/livemasterclass